CORRECTED-UPDATE 1-Republican leader offers hope for US muni bond exemption

Thu Mar 21, 2013 2:57pm EDT

(Corrects error in 7th paragraph. Republican Rep. Dave Camp does not support capping deductions generally. Error also appeared in March 20 story and Feb. 27 story.)

* State of infrastructure shows need for municipal finance -Cantor

* Cities, counties: Taxing bonds would push yields up $53.8 bln

* CBO says exemption cost $30 bln in 2011

By Lisa Lambert

WASHINGTON, March 20 (Reuters) - One of the most powerful members of the U.S. Congress, House Majority Leader Eric Cantor, signaled his support for maintaining the tax exemption for interest paid by municipal bonds, offering reassurance to the state and local governments that use the debt to finance infrastructure and other projects.

"The message was received at least in my office about the importance of that benefit," the Virginia Republican told a meeting of the National Association of State Treasurers on Wednesday.

"Lord knows we can't be pulling back on that right now given the current state of our infrastructure," added Cantor, who is the second most powerful Republican in the House.

For more than two years, President Barack Obama has suggested limiting the exemption to increase federal tax revenues.

The idea gained traction at the end of 2012, when the "fiscal cliff" crisis sent the U.S. government scrambling to bring in money without raising taxes. Some political leaders have broached doing away with it altogether.

State and local leaders say capping or eliminating the exemption will cost them billions of dollars at a time when their revenues are only just recovering from 2007-09 recession.

The chairman of the committee drafting a reform plan for the federal tax system, fellow Republican Dave Camp, has said he does not support the approach of capping deductions generally.

Investors are willing to accept less in interest payments from municipal bonds because of the exemption. That in turn keeps borrowing costs low for the issuers in the $3.7 trillion market using the bonds to finance infrastructure, schools and hospitals.

Cantor added a note of caution, saying he had recently met with members of a philanthropic organization lobbying Congress to preserve the deduction people take for donations to charities. The municipal bond tax break has "stiff competition," he said.

"You're up against the charitable deduction," he told the treasurers, who were visiting Capitol Hill to press for the exemption. "The realtors are in town at some point. You're up against the realtors and the mortgage deduction."

However, prospects for changing the exemption have dimmed. Governors, mayors, city council members, state legislators, civic officials and treasurers have kept up the heat on Congress over the last three months to maintain the exemption.

Issuers are concerned that the exemption could be capped in other legislation.

On Wednesday, 59 associations representing public officials, such as the U.S. Conference of Mayors, wrote the Senate that the budget resolution it was set to vote on "suggests the possibility of a cap being placed on tax expenditures - which could include the exemption for interest."

The resolution is non-binding and will likely not have much effect, given its wide divergences from the budget resolution under consideration in the House.

In fiscal year 2011, the U.S. government missed out on collecting $30 billion in revenues because of the exemption, according to the Congressional Budget Office.

A coalition of cities and counties said in February that if the exemption did not exist, state and local governments would have paid $53.8 billion more in interest in 2012. If Obama's cap had been in place, they would have paid an additional $18.8 billion.

Critics of the exemption said it is inefficient - that the U.S. government loses more money than state and local governments save and that it essentially acts as a tax break for the rich. (Reporting by Lisa Lambert, editing by Leslie Gevirtz)

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